(IDTT) Structural transformation along metals, machinery and equipment value chain

108 Pages·2017·1.87 MB·English

Industrial Development Think Tank (IDTT)

Structural transformation along metals, machinery and
equipment value chain – developing capabilities in the
metals and machinery segments

Zavareh Rustomjee
Lauralyn Kaziboni
Ian Steuart

18 May 2018

A collaboration between the Department of Trade and Industry, CCRED, and the SARChI
Chair in Industrial Development
This paper forms part of a series of studies on the challenges of industrialisation
undertaken by the Industrial Development Think Tank (IDTT). Established in 2017,
the IDTT is supported by the Department of Trade and Industry (the dti) and is
housed in the Centre for Competition, Regulation and Economic Development
(CCRED) in partnership with the SARChI Chair in Industrial Development at the
University of Johannesburg. The studies review trends of (de)industrialisation and
assess the potential for structural transformation to drive growth, industrialisation and
development in different sectors in South Africa.
Table of Contents
Executive summary ................................................................................................................ i
1 Introduction .................................................................................................................... 1
2 Metals, machinery and equipment value chain ............................................................... 4
2.1 Understanding the value chain ................................................................................ 4
2.2 Mapping the industry structure ................................................................................ 7
2.2.1 Internationalisation of the upstream companies ............................................... 7
2.2.2 Thinning out of the foundry sector .................................................................. 12
2.2.3 A diversified machinery and equipment Industry ............................................ 16
2.3 Competition and collusion ..................................................................................... 20
2.4 Conclusions .......................................................................................................... 22
3 Analysis of industry performance and trade data .......................................................... 24
3.1 Industry performance ............................................................................................ 24
3.2 Investment patterns .............................................................................................. 26
3.3 Trade performance ............................................................................................... 27
3.4 Conclusion ............................................................................................................ 32
4 Key issues along the value chain ................................................................................. 33
4.1 Demand ................................................................................................................ 34
4.1.1 State not supporting the local industry ........................................................... 34
4.1.2 Procurement Accord ...................................................................................... 38
4.1.3 Auto and mining OEMs providing limited support to foundries ....................... 38
4.1.4 Exporting markets .......................................................................................... 39
4.1.5 Import penetration .......................................................................................... 41
4.1.6 Conclusions ................................................................................................... 42
4.2 Input costs ............................................................................................................ 43
4.2.1 High and disproportional energy costs ........................................................... 43
4.2.2 Access to competitively priced primary metal, scrap and foundry output ........ 48
4.2.3 The cost of labour .......................................................................................... 52
4.2.4 Conclusions ................................................................................................... 54
4.3 Access to funding for investment .......................................................................... 55
4.4 Resuscitation of productive capabilities ................................................................. 60
4.4.1 Research development and technology ......................................................... 60
4.4.2 Training and skills .......................................................................................... 64
4.4.3 Conclusions ................................................................................................... 67
4.5 Clustering initiatives not taking off? ....................................................................... 68
4.6 Amendments to Mining and Mineral Policies ......................................................... 71
4.6.1 The Mineral Resources and Petroleum Development Act Draft Bill ................ 71
4.6.2 Empowerment Charter for the South African Mining and Minerals Industry .... 71
4.7 Political economy and transformation in metals sector .......................................... 72
5 Conclusions and recommendations ............................................................................. 75
6 References .................................................................................................................. 80
Annexures ........................................................................................................................... 84
Annexure 1: Interview schedule ....................................................................................... 84
Annexure 2: Intermediate input and output linkages ........................................................ 85
Annexure 3: Carbon Steel production in South Africa - Key firms .................................... 88
Annexure 4: Profiles of the “Big Four Foundries .............................................................. 85
Annexure 5: Foundry Electricity Calculations ................................................................... 86
List of figures
Figure 13: Global Steel price - Hot Rolled Coil (US$/ton) - 2000 to 2017 .............................. ix
Figure 1: Metals and machinery value chain ......................................................................... 5
Figure 2: Linkages – Metals, machinery and equipment value chain ..................................... 6
Figure 3: Commodity prices and output, 1994-2016 ............................................................ 25
Figure 4: Number of employees, 1994-2016 ....................................................................... 26
Figure 5: Gross domestic fixed investment, constant 2010-prices ....................................... 26
Figure 6: Trade balances, nominal USD millions ................................................................. 27
Figure 7: Iron and steel exports and imports, nominal USD................................................. 28
Figure 8: Machinery and equipment exports and imports, nominal USD ............................. 30
Figure 9: Cast products exports and imports, nominal USD ................................................ 31
Figure 10: Trade in value added ......................................................................................... 32
Figure 11: Local content verification process flow ............................................................... 38
Figure 12: Funding disbursements and approval, 1994-2016 in R million ............................ 59
Figure 13: Global Steel price - Hot Rolled Coil (US$/ton) - 2000 to 2017 ............................ 77
List of tables
Table 1: Upstream and downstream sections to be analysed ................................................ 2
Table 2: Estimated Annual Foundry Production (tons) ........................................................ 14
Table 3: Industry structure by foundry type ......................................................................... 15
Table 4: Opencast mining companies ................................................................................. 17
Table 5: SACEEC and cluster subgrouping joining and subscription fees, exc VAT ............ 19
Table 6: Basic non-ferrous exports and imports analysis, nominal USD .............................. 29
Table 7: Comparisons in electricity tariffs and output Hypotheticals, by foundry size .......... 47
Table 8: Proportion of direct and in-direct steel inputs in metals, machinery and equipment 51
Table 9: Effects on employment and output of lower steel prices ........................................ 51
Table 10: MEIBC wage rates (2010/11-2017/18) ................................................................ 53
Table 11: 37e Accelerated tax depreciation scheme beneficiaries - Metal sectors .............. 56
Table 12: Apprentice registrations and completions (2011/12-2014/15) .............................. 65
Table 13: Ekurhuleni and Eskom electricity charges comparison ........................................ 86
Table 14: Electricity consumption comparison, by foundry size ........................................... 87
List of boxes
Box 1: Onesteel (Australia) strategy .................................................................................... 11
Box 2: Bell Equipment ......................................................................................................... 41
Box 3: The Saldanha Project ............................................................................................... 57
Box 4: Recapitalise South Africa Cluster Programme.......................................................... 69
Box 5: Promoting transformation in the Gauteng manufacturing industry ............................ 74
Executive summary
The trajectory of South Africa’s post-war industrial development has centered on the mining,
metals and energy value chain, which has historically been characterised by very strong
intra-sectoral relationships. The mining and basic metals industries were beneficiaries of
favourable electricity tariffs, investment and logistics support aimed at promoting its
competitiveness. Subsequently, the post-apartheid state has grappled with how to engage
with the main companies (such as ArcelorMittal), including in responding to global
developments. At the same time, there have been confusing signals and measures from
different government departments and other public institutions. While the upstream
industries received substantial subsidisation, there has been limited assistance for the
downstream industries despite the importance of the basic metals and downstream
industries in fabrication and machinery and equipment as the heart of the industrial base in
South Africa.
The study assessed the status of structural transformation along the metals, machinery and
equipment value chain from the 1990s to the present day, encompassing the global
commodity price cycles of the 1990s, the 2002-2008 economic boom in South Africa and the
2008 financial crisis. Structural transformation relates to changing the sectoral composition
of the economy by increasing the proportion of higher productivity activities and high value
adding services (Nübler, 2014). Through such changes, industrialised economies have
achieved technological advancements and improved productivity, leading to employment
creation with higher income and more diverse industries.
A comprehensive set of productive capabilities would need to be in place to facilitate the shift
from low productivity to higher productive activities in each sector (sectoral deepening) and
across sectors. Such capabilities include technology, infrastructure, capital, skills as well as
policies that facilitate structural transformation (e.g. trade, investment, research and
development and exchange rate policies). For example, trade policy that supports exporting
allows firms to engage (or compete) with other companies, can prompt firms to increase
productivity to remain relevant. Technology transfer between countries, even though the
interaction between domestic innovation capabilities and imported technology is complex,
provides opportunities for technological spill overs that local firms can benefit from (Nübler,
2014). Access to appropriately qualified and trained labour force is an issue that South Africa
has been grappling with since 1994 (Daniels, 2007). Though strides have been made to
boost the level of skilled labour, this remains inadequate to meet the industry’s needs. How
these variables interact is key in addressing structural transformation along the metals,
machinery and equipment value chain.
Value chain and industry structure
The metals, machinery and equipment value chain has undergone structural transformation,
though at different levels, even within each segment. The level of structural transformation
needs to be understood within the context of the ownership and concentration of each level.
The upstream industry is mainly privately-owned by foreign-based companies. Over the
years the leading companies – Arcelor Mittal South Africa, Columbus Steel and Highveld –
have shifted their focus to achieve the respective global company’s objectives of maximising
profit and shareholder value, objectives which are not aligned with South Africa’s
developmental objectives. In 1990 the main firms in the sector were Iscor/ArcelorMittal,
Highveld Steel, Scaw, Columbus Stainless and scrap processors producing long and flat
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steel products mainly for construction sector. Since then there has been a shift from
domestic institutional ownership to foreign ownership, partly arising from conglomerate
unbundling and Iscor unbundling with assets being absorbed by TNCs during the post 2000
global steel sector consolidation.
The competitiveness and viability of upstream steel firms have been impeded by the form
that conglomerate unbundling has taken whereby the shareholder’s focus has been diffused
by multiple diverse strategic and corporate restructuring issues, the central one being short-
term profit growth. In Anglo American plc’s case, the objective of reducing exposure to the
South African economy was a further impediment in that capital expenditure on ageing plant
and equipment would have been minimised.
The experience that both Scaw and Highveld Steel were subjected to from 1998 onwards
have impeded both firms from realising their potential. Initially, Anglo plc invested in
diversifying Scaw globally through acquisition, resulting in London-controlled Scaw
becoming one of the global leaders in steel grinding media, but the post-2008 downturn
resulted in the shareholder asset-stripping the company before exiting completely. Similarly,
Highveld Steel, the third largest global producer of vanadium, was disposed of in 2007 to
Russian-owned Evraz plc. After steel and vanadium prices fell after 2008, Evraz, the second
largest global producer, initially sold a minority share to a black-owned consortium and
subsequently in 2015 put the firm into business rescue. The result of eliminating South
African supply has led to rising global vanadium prices and profits for Evraz.
Similarly, Iscor management and institutional shareholders also adopted a short-term profit-
maximising approach to maximise the sum of parts of the unbundled Iscor with a
disproportionate quantum of balance sheet debt being allocated to the steel company rather
than the Kumba Resource mining company. It was only through the intervention of the dti
and IDC that Iscor Steel emerged with a low-cost evergreen iron ore supply agreement as
well as a manageable level of debt.
But as at 2017, the main structural change is that the ownership and control of the upstream
sector is more concentrated than it has ever been by ArcelorMittal, with the likelihood that
this could increase further as Highveld and Scaw are dismembered and as the state
implements what appear to be very generous support measures for the upstream sector.
Labour productivity of the dominant steel producing firm substantially increased during the
1990s driven by the rationalisation strategies. With the exception of diversification into
stainless steel, the upstream sectors have largely reduced the steel product range supplied
to the machinery sectors.
As far as the downstream sectors are concerned, there appears to have been a
consolidation of the metal cast producers in light of the challenges that companies are
facing. While there are some firms that are performing well and are well integrated with
OEMs, it appears as though foundries are closing down precipitously as a result of local and
international pressures.
Productivity in the foundry industry has increased chiefly because employment declined at a
faster rate than output. Between 2015 and 2016, overall output declined, though an increase
was recorded in the most recent years – aluminium production has suffered the most.
Ferrous production seems to be increasing, while non-ferrous production had declined
rapidly, indicating a reduction in diversification. This reduction is also noted with the fall in
the number and type of foundries.
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The companies in the machinery and equipment sector are mainly private owned, with a
significant proportion of the companies being multinational companies. There are differing
levels of concentration between general and specialised machinery and equipment. The
specialised machinery industry is highly concentrated with a few companies commanding
significant proportion of market share, different from general machinery and equipment
where there are numerous small and medium sized companies. In the machinery and
equipment sector, MNCs also use South Africa as a conduit into the rest of the Africa.
The upstream steel sector has been receiving substantial government support to meet
stakeholder profit expectations and anti-competitive outcomes have thus far been raised in
the basic iron and steel industry. Such behaviour has had the effect of undermining the
performance of the downstream industries. The scrap metal cartel in effect raised prices for
foundries, and the excessive prices raised costs for the downstream industries.
As a result, the policy objective of changing the structure of rent allocation in the value chain
to pass the benefits of low cost resource-based iron ore inputs and low-cost steel production
structures to downstream steel users has not been achieved. The seemingly overly-
generous 3 year agreement between AMSA and the Competition Commission attempts to
achieve this. Even though it is perhaps too early to assess whether the recent agreement will
result in any change in market pricing structure and behaviour, monitoring whether the
remedies are being implemented accordingly will be key.
Industry and trade performance data
The metals, machinery and equipment value has recorded growth in output over the time
period under analysis, mainly driven by movements of the commodity prices. In other words,
during periods where the commodity price cycle was on the rise, a commensurate growth
was seen in the output for all for subsectors. Despite the growth in output, there are notable
differences in employment trends among the industries.
The investments which took place in the early 1990s for the basic iron and steel industries,
resulted in a more capital-intensive upstream industry which consequently shed many jobs.
At the same time, the labour intensive metals, machinery and equipment sectors have in fact
grown employment, even during periods when output was depressed. With regards to
investment, machinery and equipment is the only sector that appears to have grown
investment between 2011 and 2013, which could be attributed to investments in mining,
development of energy and water sectors in SADC.
Trade performance of the metals, machinery and equipment value chain has shown to be
very closely linked to the exchange rate movements. The appreciation of the rand in the
2000s, during the commodity boom, rendered South African products less competitive than
international products. As a result, the highly tradeable fabricated metals, machinery and
equipment were exposed to high import penetration. The excess demand in the local
industry was thus met by imports, despite the growth in output and exports between 2002
and 2008. Since 2008, the rand has been depreciating, and this has coincided with the
improvement of the fabricated metals, machinery and equipment sectors.
The basic iron and steel industries are a net exporter along with the main non-ferrous
industries such as copper, nickel and aluminium. The upstream industries export more into
Asia, Europe and the USA. Between 2002 and 2008, we also notice the growth of exports in
these industries. This growth may be attributed to the rise in commodity prices and not
actually an increase in tonnage.
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For the fabricated metals, machinery and equipment, there is a growing importance for
Africa as a trading partner. The trade balance for both machinery and equipment and metal
cast products worsened between 2002 and 2008 during the commodity boom, highlighting
significant losses in employment and output growth. Nonetheless, the machinery and
equipment sector has remained quite resilient, showing signs of improved trade balance in
the last decade or so. The downstream industries are also becoming more integrated into
global value chains given their tradability.
The performance of the downstream industry has been suboptimal despite their contribution
to employment. The foundry and machinery and equipment sectors are facing declining
demand for their products, as demand is being increasingly met through imports. The
decline of the downstream industry and increasing import penetration emphasises the need
to address the factors that have hampered the growth and development of the downstream
industries.
Key issues along the value chain
Domestic and regional demand
While procurement policies are aimed at driving localisation, poor implementation and weak
monitoring and evaluation processes have resulted in local firms losing orders, requisite for
achieving economies of scale. This is partly attributed to the lack of support from state
owned companies and municipalities – the largest procurers and demand drivers – under the
National Industrial Participation Programme, the Preferential Procurement Policy Framework
Act, and even the Competitive Supplier Development Programme. Evidence shows that
government entities are violating industrial policy objectives and are employing different
tactics to avoid procuring locally (through exemptions), and are resorting to imports. The
weak implementation of the policy is exacerbated by the fact that the appointed verification
agency does not have funds to undertake verification. Loopholes in the calculation of local
content have also undermined the intended consequences of local procurement. However,
there seems to be a drive at the dti to improve the implementation of the policy.
In 2011, government, the private industry (through Business Leadership South Africa)
business and labour as well as community representatives signed a Local Procurement
Accord aimed at creating 5 million new jobs by 2020. Government committed to leverage
public procurement, establish standards for measurement and verification of local content
and accelerate infrastructure investment. Business through Business Leadership South
Africa (BLSA) committed to progressively increase the levels of local procurement by its 84
members by establishing a baseline, developing strategies and targets and reporting on
annual basis. Subsequently, the BLSA commissioned a study which delivered two reports in
2012. However, it does not appear that BLSA took the process any further than
disseminating the reports to their members.
Poor local demand, and high import penetration have tremendously affected local firms. The
weakening of capabilities in the foundry industry have also meant that some component
manufacturers have resorted to importing standard components. This has the effect of
worsening the competitiveness of the downstream industries.
The ambitions to drive local procurement, accompanied by the high levels of import
penetration means that local firms need to explore other markets. As such that most firms
have resorted to entering the export market, particularly SADC. Even here South African
firms are losing market share due to decline in competitiveness, change in ownership of
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mines and lack of access to export finance. Export-finance is vital for supporting and
facilitating trade, especially when competing with other foreign companies that have access
to this facility.
The upstream sector has managed to maintain international competitiveness due to the
incentive (GEIS until 1997) that assisted in the penetration of export markets and by market
access secured by various trade policy negotiations. Import penetration at the upstream
level has occurred among steel grades that the local companies do not manufacture, as
such import penetration has had little, if any impact on their demand.
Input costs
Access to competitively priced inputs – electricity, raw materials and labour – determines the
competitiveness of the value chain. This is particularly important for foundries and machinery
and equipment that have strong backward linkages with the upstream industry. Furthermore,
the foundry industry has strong forward linkages with the machinery and equipment, such
that the performance of the foundry sector relates to the production of certain machinery and
equipment.
The cost and supply structure of electricity is structurally biased towards high voltage
customers compared to low voltage customers. While energy intensive upstream industries
source energy directly from Eskom (at a lower tariff), downstream industries either access
electricity from Eskom or municipalities depending on the manufacturing plants’ location.
There is strong evidence to suggest that companies supplied by Eskom directly pay lower
tariffs for electricity compared to municipalities. Even among municipalities, there are
different pricing structures. Municipalities charge higher electricity rates (difference of about
29%) than Eskom because for municipalities, electricity is an important source of revenue.
The price differentials not only affect how local firms compete amongst themselves, but also
how they compete in the international market.
The weak policy implementation of the MPRDA, with regards to beneficiating ore in South
Africa, has affected the upstream industry, following the loss of primary steel sector to its
cost-based supply link with the iron ore sector in 2008, an event in which the Department of
Mineral Resources appears to have fully supported. Poor policy implementation of the Price
Preference System has resulted in leakage (exporting) of scrap material. Even though local
foundries are given first choice when procuring scrap material, scrap merchants are finding
ways to export the scrap and earn higher profit. As a result, local foundries either have
access to poor quality scrap or have to purchase scrap at exorbitant prices. In order to
circumvent this, an export tax on scrap could be ideal, though this would need to be
differentiated between ferrous and non-ferrous scrap.
For the machinery and equipment sector, the protection enjoyed by the upstream industry
coupled with the poor performance of the intermediate foundry industry is a double-
whammy. The current and envisaged protection on the steel industry will increase the costs
for local manufacturing, further hampering their competitiveness. The challenges in the
foundry industry have led to firms importing cast components, which is suboptimal.
The evidence presented in our research suggests that annual real wages increases for
workers in the metals industry (at least since 2010/11) have been relatively modest. That
said, the productivity of labour in South Africa has, at best, stagnated over the past 10 years.
In the absence of research on the severity of industry-specific strikes it is difficult to make
any strong conclusions regarding the impact of strike action on the industry. As with all small
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